BloombergTV Daybreak: February 7, 2018

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Key Points:

  • US centric correction, ROW Outperforming
  • Speed of equity mkt advance ran into speed of rate backup
  • Short volatility wipeout a classic example of picking up nickels in front of a steamroller; sooner or later you are gonna get rolled
  • Key Q is whether non US equity mkts can sustain outperformance & thus confirm regime change & non US equity leadership
  • Buy weakness in GO SOUTH mkts in Europe, Asia and Latin America

Catalysts for correction: speed of rate back up & inflation worry  - higher rates had been bullish for stocks for much of 2017 as the rise in rates confirmed the global growth recovery which supported rising EPS. The speed of the rate increase in the past few weeks has been unnerving and the better than expected jobs gains and AHE # Friday morning reinforced the sense that perhaps inflation is really coming and thus rates will have to move even higher, leading to stocks selling off.

I also think the political environment in DC does not help as the Nunes memo was released on Friday and the news cycle was filled with chatter about a pending Constitutional crisis - given that the US is a huge debtor requiring constant infusions of offshore capital to fund its debt such talk is not constructive for risk assets.

The pick up in selling led to an implosion in the short vol or short VIX trades which no surprise had been among the best performers in 2017 - it brings to mind the old market adage about picking up nickels in front of steamrollers - sooner or later you are gonna get run over and thats what happened. 

The return to volatility is good for markets just as the return to inflation is good for the economy. A little inflation can go a long way to helping the economy, companies and workers…. a little volatility can help keep investors honest and allow markets to price risk correctly. The sharp run up in equity prices in January strongly suggested risk was not being priced correctly ( see comments below about not being able to find ANY attractive charts) and so the volatility spike, while overdone, will probably help equity markets have a better yr than if it had not happened. In other words we were heading for a fall and so better sooner rather than later.

Bond yields don't trouble me very much… as noted above it was the SPEED of the rate backup that was a little unnerving. Given the broadest and best global economic recovery in a decade or more one would expect rates to back up somewhat, in the US and in Europe in particular. I believe there is a lot of capital that continues to search for long duration safe assets and so I think the back end of the yield curve should be pretty well behaved though a weak dollar means losses for Euro, Yen and RMB based investors as Table One in Go SOUTH shows. As a global multi asset investor, rising rates suggest my benchmark, a 60-40 global equity/debt composite, should in fact be easier to beat bc bonds will not do as well as in the past few yrs. To wit, that benchmark was up 15% last yr - that is tough to beat… this yr should be easier.

From an equity mkt perspective the worry was that the fiscal stimulus was going to lead the Fed to tighten too much too fast and risk inverting the yield curve which has traditionally been the kiss of death for equities - the latest gyrations have led to a widening of the yield curve which is good news.

GO SOUTH piece published in late January discussed a correction and suggested buying the laggards by which I meant the Southern Tiers in the Tri Polar World's three main regions: Europe, Asia and Americas - I was a buyer of Greece (GREK) and Italy (EWI) equity yesterday. 

We had our monthly Portfolio meeting last Thurs - Fri and it was V difficult to find an equity chart – any country, any sector, anywhere in the world - that didn’t look V extended. The only exceptions were the fixed income type sectors like Utilities etc.

That suggests the selloff - profit taking is V healthy bc it will allow one to reposition on the fundamentals without having to worry that the technical/sentiment stuff is gonna bite you… as we have seen.

Bottom line – a US centric, late cycle, healthy pullback - gets rid of the hype and allows one to refocus on the fundamentals of a solid, synchronized global recovery. Equity mkt weakness presents an opportunity to buy the Tri Polar World's regional laggards which are the most leveraged to the global recovery. Key Q is sustained non US relative outperformance to confirm global equity leadership regime change.